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Mean Street: If Lehman Liquidates, Wall Street Gets Set to Make a Killing
Posted by Deal Journal
So this is the way it ends. Not with a bang but a whimper–Lehman Brothers looks headed into liquidation.

Apparently, you can put dozens of Wall Street’s finest into conference rooms at the Federal Reserve Bank of New York, but they can’t rewrite an immutable law of human nature: people act in their self-interest.

And it is in everyone’s narrow interest–except for Lehman’s shareholders, debt holders and employees–to see Lehman in bankruptcy proceedings.

Over the weekend, it has become clear that Lehman is a zero sum game. Slice it and dice it. Ring fence asset manager Neuberger Berman. Put the commercial mortgages into a separate vehicle. But the $53 billion of illiquid assets that Lehman has on its books are still bad assets.

Early on the Treasury Department made it clear the U.S. taxpayer doesn’t want these assets. Barclays and the Bank of America don’t want them either. So the Treasury has tried without success to convince Lehman’s Wall Street brethren to take them on.

But why should they?

Imagine you are John Thain, CEO of Merrill Lynch. Unlike Dick Fuld, who has held tight, in July you sold collateralized debt obligations with a face value of $31 billion at 22 cents on the dollar. But you still are capital constrained.

And now you are asked by Treasury Secretary Hank Paulson, the man who didn’t make you CEO of Goldman Sachs, to put up billions of dollars to save Lehman? So that Barclays or BofA can pick up Lehman on the cheap to compete with you? It is humiliating enough that you may soon need one of those banks to bail you out. Indeed, the Wall Street Journal reports that BofA and Merrill are in merger talks.

You can see Goldman Sachs CEO Lloyd Blankfein and Morgan Stanley CEO John Mack offer up a couple of billion dollars apiece as acts of noblesse oblige. They know a Lehman bankruptcy would be a big headache come Monday when the credit markets freeze up.

But “unselfish” acts have their limits. Goldman has billions of dollars dedicated to distressed debt situations just like this. It may very well run counter to the interests of Goldman investors and shareholders to subsidize any deal for Lehman.

This is where the Lehman death drama turns into farce. It isn’t a shortage of outside capital that is driving Lehman into bankruptcy. It is the bid-ask spread on its bad assets, or the difference between a buyer’s and seller’s views on price.

Sure, the $53 billion in assets are illiquid, but at some price there is a buyer. Are the assets worth 10 cents on the dollar or 50 cents on the dollar? Dick Fuld was afraid to find out because he knew that at 10 cents, Lehman likely was bankrupt anyway.


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• And get all the day’s Deal Journal blog posts delivered straight to your inbox: Click here to automatically sign up for the new Deal Journal Newsletter.Still, there are tens of billions of dollars of Wall Street capital happy to bid for the assets. Goldman, private-equity firms like J.C. Flowers, Kohlberg Kravis Roberts, Carlyle Group, TPG or Blackstone Group, hedge funds, distressed-debt funds and sovereign-wealth funds all have capital. They are just waiting for the clearing prices on Lehman’s assets to get attractive.

Which is why a Lehman bankruptcy makes sense. Instead of a complex game of chicken between the U.S. Treasury and Wall Street, you have a straightforward auction. Lehman is broken up and its assets sold to the highest bidder. Only in this way will each buyer and the seller be able to fulfill its obligation to act in its self-interest.

Yes, but what about the collective well-being of the markets? What about a feared-for financial apocalypse brought about by the unwinding of Lehman’s $600 billion balance sheet?

It may not be pretty, but apparently Wall Street has decided that the price won’t be too steep. Or else, it would have put up the money.

If a Chapter 7 filing is made, Wall Street will move on. In offices and conference rooms not far from the New York Fed, bankers probably are already gathering to prepare for bids on assets they hope to pick up on the cheap in any potential Lehman liquidation.

In the coming weeks, Wall Street’s vultures will pick over Lehman’s still-warm body–and wait for one or two more victims to come their way.
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